The Top 8 Real Estate Calculations Every Investor Should Memorize

Despite what many of us math-allergic folk would prefer, real estate does involve some math. Luckily, most of the formulas are simple and straight-forward. In fact, if you can master the calculations below, you should be just fine.

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The Top 8 Real Estate Calculations Every Investor Should Memorize

Cap Rate

Net Operating Income / Total Price of Property

Example:

NOI: $25,000

Total Price (Purchase + Rehab): $300,000

$25,000 / $300,000 = 0.083 or an 8.3 Cap Rate

This calculation is mostly used for valuing apartment complexes and larger commercial buildings. It can be used for houses and small multifamily too, but operating expenses are erratic with houses (because you don’t know how often and how bad your turnovers will be).

You want to have a cap rate that is at least as good, preferably better, than comparable buildings in the area. I almost always want to be at an 8 cap rate or better, although in some areas, that’s not really possible. And always be sure to use real numbers or your own estimates when calculating this. Do not simply use what’s on the seller-provided pro forma (or as I call them, pro-fake-a).

Rent/Cost

Monthly Rent / Total Price of Property

Example:

Monthly Rent: $1,000

Total Price of Property (Purchase + Rehab): $75,000

Rent/Cost = $1,000 / $75,000 = 0.0133 or a 1.33% Rent/Cost

This is a great calculation for houses and sometimes small multifamily apartments. That being said, it should only be used when comparing the rental value of like properties. Do not compare the rent/cost of a property in a war zone to that in a gated community. A roof costs the same, square foot for square foot, in both areas. And vacancy and delinquency will be higher in a bad area, so rent/cost won’t tell you what your actual cash flow will be. The the old 2% rule can lead investors astray, and they shouldn’t use it. But when comparing like properties in similar areas, rent/cost is a very helpful tool.

According to Gary Keller in The Millionaire Real Estate Investor, the national average is 0.7%. For cash flow properties, you definitely want to be above 1%. We usually aim for around 1.5%, depending on the area. And yes, I would recommend having a target rent/cost percentage for any given area.

Gross Yield

Annual Rent / Total Price of Property

Example:

Annual Rent: $9,000

Total Price (Purchase + Rehab): $100,000

Gross Yield = $9,000 / $100,000 = .09 or a 9% gross yield

This is basically the same calculation as above but flipped around. It’s used more often when valuing large portfolios from what I’ve seen, but overall, it serves the same purpose as rent/cost.

Debt Service Ratio

Net Operating Income / Debt Service

Example:

NOI: $25,000

Annual Debt Service: $20,000

Debt Service Ratio = $25,000 / $20,000 = 1.25

This is the most important number that banks look at and is critical for getting financing. Generally, a bank will look at both the property’s debt service ratio and your “global” debt service ratio (i.e. the debt service ratio of your entire company or portfolio).

Anything under 1.0 means that you will lose money each month. Banks don’t like that (and you shouldn’t either). Generally, banks will want to see a 1.2 ratio or higher. In that way, you have a little cushion to afford the payments in case things get worse.

Cash on Cash

Cash Flow / Cash In Deal

Example:

Cash Flow (Net Operating Income – Debt Service): $10,000

Cash Into Deal: $40,000

Cash on Cash: $10,000 / $40,000 = .25 or 25%

In the end, this is the most important number. It tells you what kind of return you are getting on your money. In the above example, if you had $40,000 in the deal and made $10,000 that year, you made 25%. This is a critical calculation not only when it comes to valuing a property, but also when it comes to evaluating what kind of debt or equity structure to use when purchasing it.

The 50% Rule

Operating Income X 0.5 = Probable Operating Expenses

Example:

Operating Income: $100,000

Operating Expenses = $100,000 * 0.5 = $50,000

This is a shorthand rule that I judge to be ok. It is for estimating the expenses of a property. Whenever possible, use real numbers (i.e., the operating statement), but this is good for filtering out deals that don’t make sense. Just remember, a nicer building will have a lower ratio of expenses to income than a worse one and other factors, like who pays the utilities come into play. Don’t simply rely on this rule.

The 70% Rule

Strike Price = (0.7 X After Repair Value) – Rehab

Example:

After Repair Value: $150,000

Rehab: $25,000

Strike Price = (0.7 X $150,000) – $25,000 = $80,000

This is another rule like the 50% rule, although I think this one is better. This one is for coming up with an offer price. Always crunch the numbers down to the closing costs before actually purchasing a property. But if you offer off the 70% rule, you should be just fine as long as your rehab estimate and ARV (After Repair Value) estimates are correct.

Comparative Market Analysis

Unfortunately, there’s no real calculation for this. It’s mostly used for houses, and it’s all about finding the most similar properties and then making adjustments so that a homeowner or investor would find each deal identical. The MLS is by far the best for this, but Zillow can work too (just don’t rely on the Zestimate). For a more detailed explanation, go here.

In the end, the math isn’t that bad. No rocket science here luckily. Instead, there are just a few handy calculations and rules to evaluate properties before purchase and analyze their performance afterward. Memorize these, and you should be fine.

Investors: What formulas do you use to analyze your deals? Any calculations you’d add to this list?

Let me know with a comment!

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Good summary! I was recently talking with my son (business guy with Nike) and his question was “what is your return on equity?” From the metrics you presented, I’m doing fine. But when I looked at my Return on Equity, I was a bit stunned! As a buy & hold guy, the longer I hold something the higher my cash flow, but without reinvesting the equity the lower my return on equity! Any thoughts on the value of this formula and how to balance that with other formulas?

I’m definitely the most interested in my return on cash, but yes, as a buy and hold guy as well, as you pay down more principal, your return on equity will go down. I’m not as concerned about this for two reasons 1) your equity continues to go up, especially as you get further into the loan and your principal paydown accelerates and 2) the transaction costs involved in moving to another investment. Overall, my strategy is to grow the amount of equity I have first and foremost, so I’m OK with having a bit lower return on equity as everything else is good.

I think as a buy and hold investor, especially in an area where significant appreciation is happening, it’s worth calculating return on equity.

I re-evaluate my properties yearly because, while my cash on cash has stayed good the properties have often appreciated so much that my return on equity sucks. I need to re-allocate (cash out refi or sell and buy something else).

Some of my units are in an area that really hasn’t had significant appreciation in ten years. I never do return on equity for them, because nothing has really changed. YMMV.

I’m a newbie here and first I want to say thank you for the great article. I’m not in real estate investing yet. My thought is how do successful investors get around the day to day hassle of bad tenants and their drama? It seems like as an owner of many properties it could make one’s life hell. I know a woman who had her tenant put a restraining order against her for giving her an eviction notice. She couldn’t do anything about it and had to go to court several times.
I am hesitate to move forward due to this issue. I was thinking that business properties may be less hassle, any thoughts on this?

Thanks! This is very helpful. One question regarding Debt Service Ratio:
– if DSR = (Annual NOI/Annual DS), then isn’t DS being counted twice?
– I was under the impression that NOI = (Gross OI – OE) and…
– that OE includes DS.
Should DS not be included in OE or am I misunderstanding something?

Great article!
I know most of these, but learned some new stuff for sure. I also use some additional metrics, the break even ratio and reserve ratio.

BER = (Debt Service + Operating Expenses) / Gross Operating Income.

The objective is to have this number as low as possible, but no higher than 85%. If the BER=100% then that is like having a DSR=1.0.

The other metric is my reserve ratio or number. This is actually one of my top metrics that I calculate. I want to make sure that when I purchase the asset or get into any kind of deal that I (or the deal) have/has sufficient reserve capital if something goes sideways I’m covered and don’t have to come more out of pocket. This is a hard number to pin down in a rule, but depending on the deal, I like to have 3-6 months minimum reserves if not 12 mo of reserves. Having reserves which are then replenished from the gross income to a given % or level can heal a lot of ill’s in a deal.

All important calculations. While it’s not easy to calculate and talk about in a blog post, I would argue that IRR is really the most important calculation – more important than CoC (because it takes value of equity and sale costs into account), more important than ROE (because it assumes any free cash flow is re-invested), more important than anything else (because it accounts for the variables related to your strategy with the property).

I think the post would be improved if – even if it didn’t cover the topic in detail – it at least pointed people at how to start thinking about it.